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George F. Bearup, J.D. Senior Legal Trust Advisor

15-Feb-18

It’s Time to Revisit Durable Powers of Attorney

Take-Away: Clients should be encouraged to review, and update, their Durable Powers of Attorney for financial management purposes in light of the new federal gift tax exemption amounts and rights that may  they may hold under estate planning documents.

Background: A durable power of attorney is a power of attorney where the principal designates another as the principal’s attorney-in fact-to make financial and property decisions on behalf of the principal.  The attorney-in-fact is referred to as the agent. [MCL 700.1103(a).]

  • Durable: The power of attorney is durable when it contains words like: This power of attorney is not affected by the principal’s subsequent disability or incapacity, or by the lapse of time, or This power of attorney is effective upon the disability or incapacity of the principal or words of similar effect. [MCL 700.5501(1).] This required language is necessary to overcome the common law legal principle that an agency relationship is automatically terminated when the principal becomes mentally incapacitated. Usually the durable power of attorney is executed with the principal’s future mental incapacity in mind, with the intent that the agent will be able to handle the principal’s financial affairs without the need to have a conservator appointed by a probate court.
  • Fiduciary Duties: The agent owes common law fiduciary duties to the principal, including the prohibition against self-dealing, unless the power of attorney instrument expressly authorizes self-dealing by the attorney-in-fact with the principal’s assets.
  • No Implied Power to Make Gifts: One of the critical powers often conferred upon an agent under a durable power of attorney is the authority to make gifts of the principal’s assets. But that power must be expressly delegated to the agent under the durable power of attorney instrument. In fact, the power to make gifts is not presumed to have been granted to the agent under a ‘broadly’ worded power of attorney such as ‘My agent may hold all the powers that I hold over my assets without limitation.’ In Michigan, the power to make gifts must be expressly granted. The Estates and Protected Individuals Code [EPIC] provides: The attorney-in-fact shall not make a gift of all or any part of the principal’s assets, unless provided for in the durable power of attorney, or by judicial order.’ [MCL 700.5501(3)(d).] Therefore, in the absence of a delegated power to make gifts using the principal’s assets, the agent cannot make any gifts.
  • No Implied Self-Dealing: Along these same lines, the agent who acts under a durable power of attorney cannot create an account or other asset in joint tenancy between the principal and the attorney-in-fact unless the durable power of attorney instrument expressly grants that power to form a joint ownership arrangement between the two [agent and principal] under the attorney-in-fact arrangement. [MCL 700.5501(3)(e).]
  • 2018 Gift Tax Rules: Prior to the passage of the 2017 Tax Act (the Act), the annual exclusion gift amount increased to $15,000 per donee. [IRC 2503(b).] The federal gift tax exemption amount increased under the Act from $5.45 million per taxpayer to roughly $11.2 million per taxpayer. Moreover, the ability to make direct gifts of unlimited amounts in the payment of the donee’s tuition or medical expenses continues, a transfer of wealth option that is often underutilized by a donor in an era rising medical expenses and escalating college tuition costs. [IRC 2503(e.)] With the dramatic increase in the federal gift tax exemption amount from $5.45 million to $11.2 million, we can expect that a lot more clients will now consider lifetime gifts in recognition that the gift tax exemption amount is scheduled to fall back to $5.45 million in 2026.

Why Revisit Durable Powers of Attorney?: With the shift in planning emphasis from saving federal estate taxes to saving federal income taxes, coupled with the doubling of a taxpayer’s lifetime gift tax exemption, there exists the need to have more flexibility for tax planning in a durable power of attorney, and arguably more discrete powers held by the agent under a durable power of attorney if the principal is incapable of engaging in the planning themselves. As noted earlier, if the durable power of attorney is silent with regard to agent’s the ability to make gifts, then the agent is incapable of making a gift using the principal’s assets. Nor can the agent make assets joint with the principal if the goal is to avoid probate, if the durable power of attorney is silent on this grant of authority. The durable power of attorney needs to be reviewed for several reasons, including:

  • Make Lifetime Gifts: Older durable power of attorney instruments that granted the agent the authority to make gifts often  limited the ability to make gifts only of the annual exclusion amount [$15,000 for 2018.] Many clients may want to use their new $5.0 million federal gift and GST tax exemptions to fund spousal lifetime access trusts (SLAT) or charitable remainder trusts (CRT) or long-term dynasty trusts for children and grandchildren to avoid estate taxes for several generations. If the durable power of attorney is limited to the agent making annual exclusion gifts then these long range planning opportunities will be unavailable to the agent.
  • Pay Tuition and Medical Expenses: Often the durable power of attorney instrument is silent on the ability to make direct gifts of tuition or medical expenses of an unlimited amount. Or, the instrument only grants the authority to make gifts pursuant to IRC 2503(b)- the annual exclusion gift opportunity of $15,000 a year. If a delegation of authority to the agent by a grandparent to make gifts is restricted to IRC 2503(b), and it does not include reference to IRC 2503(e) gifts,  the agent could not then make a direct gift of say $53,000 to pay for the principal’s grandchild’s tuition at Northwestern University. A power of attorney is governed by the law of agency, which means that the delegated power will be narrowly construed by a court. Griswatch v Niedzwiecki, No. 27188, 2008 Mich App LEXIS 831 (April 24, 2008.)
  • Income Shifting Through Lifetime Gifts: Assume a grandfather, a high salaried CEO of company,  is currently at the highest marginal federal income tax bracket (37%.) He has 4 grandchildren in their early 20’s with modest earnings from their jobs. Grandfather gives $1.0 million income producing stock to each grandchild. Grandchildren, who are in the 10% to 12% marginal income tax brackets, receive and report the stock dividends on their personal income tax returns. Five years later the grandfather retires and  his generous CEO salary disappears. The grandchildren could then ‘gift’ back to their grandfather their $1.0 million of stock which their grandfather will then invest and report the dividend income from, but at a time when grandfather is at a lower marginal income tax bracket in retirement. None of this type of ‘income shifting’ planning using large gifts can take place if the power given to the agent under a durable power of attorney to make gifts in excess of the annual exclusion amount is not given in the durable power of attorney.
  • Defer Capital Gains: Assume a client has experienced a tremendous growth in their investment portfolio during 2017. They want to diversify their portfolio, but they do not want to pay capital gain taxes on that diversification. The client could transfer the appreciated marketable securities to a charitable remainder unitrust (CRUT) and as trustee of the CRUT  sell the appreciated assets without capital gain recognition. Since the CRT is treated as a tax exempt entity, it can sell the appreciated securities and not incur an immediate capital gain tax- the gain is reported ratably over the client’s lifetime as distributions are made from the CRUT to the client. All of the sales proceeds (not just the after-tax amount) can then be reinvested and used to pay to the client a fixed percentage of the CRUT assets for the balance of the client’s lifetime. If the client is incompetent, can their agent under the durable power of attorney create a CRUT and transfer assets into the CRUT to defer the gain recognition on the CRUT’s assets? Maybe, then again, maybe not, depending on the scope of the gift power the durable power attorney grants to the agent.
  • This was the problem in the infamous 2017 Tax Court decision Estate of Powell v. Commissioner, 148 T.C. 18 (2017.) The son, who held his incapacitated mother’s durable power of attorney, created a limited partnership and transferred $10 million of his mother’s assets to the partnership in exchange for limited partnership interests. The son, again using his mother’s durable power of attorney, then transferred all of her limited partnership interests to a charitable lead annuity trust (CLAT). The mother died about a week later. The son took the position that none of the limited partnership interests were in his mother’s taxable estate as she (he, using his mother’s durable power of attorney) had gifted all of her limited partnership interests to the CLAT. In taxing the full $10 million value of assets in the mother’s estate, the Tax Court found that the durable power of attorney relied upon by the son for these multiple planning steps only gave the son the power to make annual exclusion gifts, not a $10 million gift of limited partnership units to the CLAT. As such, the gift to the CLAT was voidable and not binding, which resulted in $10 million of assets taxed in the mother’s estate.  While there were other egregious facts that led to the Tax Court’s decision, Powell’s message is clear that the gift provisions in a durable power of attorney need to be tailored to permit whatever type of gift or other lifetime transfers by the agent that might be appropriate in tax planning the incapacitated client’s estate, but powers perhaps that are constrained by accounting responsibilities imposed on the agent to third parties to prevent an abuse by the agent with the extraordinary power to make lifetime gifts.
  • Exercise Powers of Appointment: Usually a durable power of attorney contains a long litany of powers conferred on the agent. However, many of those delegated powers are pretty general in nature and do not reflect, nor are they directed at,  some of the more modern trust and estate planning techniques found in wills and trusts. For example, many trusts these days grant to the beneficiary a power of appointment over trust assets,  or retained  rights over assets not held in trust, e.g. ‘ladybird’ deeds. The exercise of a power of appointment is not the same thing as creating a will for the principal, but an exercised power of appointment in favor of certain appointees can still have the same effect as executing a will in that exercising the power of appointment can determine who will receive assets such to the power on the power holder’s death. Since a power of appointment is not a ‘contract,’ a durable power of attorney provision that authorizes the agent to ‘enter into contracts’ on behalf of the principal would not authorize the agent to exercise a power of appointment held by the principal. Again, as mentioned above, just as a durable power of attorney should be tailored to the assets held by the principal and possible estate planning with regard to those assets, the same consideration should apply to the rights held by the principal, like the principal’s ability to exercise a power of appointment to direct assets held in trust. The clearer those powers are given to the agent to exercise (or to not exercise) rights, the less room there is for debate at a later time  to assure that the agent’s exercise of the principal’s rights is not voidable.

Conclusion:  With the 2017 Tax Act there is good reason to revisit existing durable powers of attorney and refresh them to meet the rights of the principal as well as provide the required flexibility to adapt an incapacitated principal’s estate plan.